Reservation of Rights Letters
The policy was purchased. The insured got sued. The insurer got notification. The insured expected coverage, but the insured got a reservation of rights letter. What does a reservation of rights letter mean with regard to coverage? It means, “don't count on it.” The insurer is saying that it may not provide coverage for the claim, but it's not ready to make that determination, so it wants time to straddle the fence for a while. Danger. A denial of the claim without adequate investigation places the insurer in one kind of danger. Proceeding to defend the claim without preserving its rights places the insurer in another kind of danger. What would happen if the claim were denied without justification? You guessed it (or maybe not)—breach of contract, bad faith and extracontractual damages. What's the problem with offering to defend the insured until the investigation and coverage decision is made? You guessed it (or maybe not)—waiver and estoppel.
Waiver. Let's take a look at waiver and estoppel. Waiver occurs when an insurer voluntarily relinquishes a known right, typically found in the conditions of the policy. Recently, the Federal Emergency Management Agency notified National Flood Insurance Program policyholders affected by Superstorm Sandy that the policy requirement to submit a proof of loss within 60 days was being extended another 60 days. In so doing, the NFIP waived its contractual right to receive the proof of loss within 60 days. Having waived its right, the NFIP cannot later attempt to reinstate its right and deny payment when the proof of loss is received 100 days after it was requested.
Estoppel. The legal concept of estoppel is a little more abstruse than waiver. It occurs when an insurer is unable to assert a defense because the insurer's prior behavior is now inconsistent with that defense. In other words, the insurer is not permitted to change its mind in the performance of a promise (in the policy) to the disadvantage of an insured who relied upon that performance. Certainly, estoppel would be involved in preventing the insurer from asserting rights previously waived. However, estoppel goes beyond the intentional waiting of a right to include mere representations of fact that are either expressed or implied. As long as evidence shows the insured was harmed by a good faith reliance upon the insurer's representation, the insurer can be estopped from enforcing even express policy exclusions.
The way an insurer reacts to an insured's behavior or the circumstances surrounding a loss can potentially lead to estoppel. Suppose an insurer defends an insured under a liability policy for two months before discovering an exclusion would apply to the insured's coverage. If that insurer continues the defense for two more months before denying coverage, to the disadvantage of the insured, the insurer would be estopped from enforcing the exclusion. New York has a statute [Insurance Law Section 3420(d)] that precludes denial, regardless of prejudice, when an insurer waits an unreasonable amount of time to disclaim coverage after the basis for denial has become known. However, this rule is applicable only to liability claims for bodily injury or death.
Disputes. Quick action by an insurer is required when potential coverage disputes begin to appear. Some of the circumstances that lead to disputes tend to occur with frequency. These include:
- the insured's failure to cooperate with the insurer;
- the insured's failure to provide prompt notice of claim;
- the insured is suspected of fraud or arson;
- the application of an exclusion may preclude coverage;
- the event did not fall within the policy period;
- there is a mix of covered and noncovered allegations;
- the defendant is not an insured; and
- the loss may have been expected, intended or foreseen.
Reservation of rights. When coverage is disputed, the insurer may choose to file a declaratory judgment action in order to get resolution on the matter from the court. Usually, this occurs when the insurer is more certain of its position. In the absence of such certainty, the insurer may continue the investigation, but preserve its rights in a reservation of rights letter. The reservation of rights letter is not a contract (unlike the nonwaiver agreement discussed later), but merely a notice. Nevertheless, this notice likely will present facts and opinions that the insured does not agree with and the insured will not want these statements to go unchallenged. Consequently, the insured should go on record with a letter in response that addresses the disputed facts, unreasonable policy interpretations and attempts to reserve rights that are not supported by policy provisions or state regulation.
Most importantly, a reservation of rights letter is a signal to the insured that the insurer has a conflict of interest and the insured better look after his own interests. Where there is a conflict of interest with regard to a liability claim, the insured needs to know the defending law firm is not divided in its loyalties. The insured should determine that the insurer-appointed counsel truly is independent and not dependent on the insurer for referrals. And, even if independent, does the counsel chosen have sufficient expertise for the type of suit filed? Another consideration is the insurer's policy toward legal expenses. Does the insurer's payment scheme result in the highest quality defense for a defendant that may end up self-insuring all damages awarded?
The insured has the option to hire separate counsel to look over the shoulder of the insurer-appointed counsel. When the insurer reserves its rights in some jurisdictions, such as New York (see Public Service Mutual Insurance Co. v. Goldfarb, 53 NY2d 392,401), the insured is permitted to choose his/her own counsel and the insurer is billed for the expenses. In summary, an insured should use all means available to control the defense to the extent that the insured is satisfied that his/her interests are protected.
Nonwaiver agreement. Unlike the reservation of rights letter, a nonwaiver agreement is a contract that requires the signature of the insured. In terms of its effect on the insured, a nonwaiver agreement is either going to be the equivalent of a reservation of rights letter or it will be worse. Not only does the agreement affirm the insurer's reservation of rights, but it may even add to those rights while withdrawing rights afforded the insured in the policy. In most cases, the insured has nothing to gain by signing a nonwaiver agreement and should not do so without seeking independent counsel.
Producer involvement. While a producer should stop short of providing legal advice, assisting policyholders through the claim process is what distinguishes a producer's value to clients. There is no duty to provide this guidance, but once it is offered, a duty is created to provide accurate and reliable information. Personnel in an agency that provide this service to clients should be trained to be proficient in these matters.
The following are some types of assistance that would be appropriate to give a claimant who faces an insurer's reservation of rights.
- As soon as the producer knows an action to reserve the insurer's rights is likely to be taken, the producer should forewarn the claimant.
- The producer should explain the purpose of the reservation of rights letter and how it will affect the claimant.
- The producer should identify the appropriate options available for responding to the reservation of rights letter.
- The producer should function as an advocate for the claimant with respect to coverage interpretations.
When evaluating the insurers, a producer intends to quote a client, consideration should be given to the precedent those insurers have set with regard to their utilization of reservation of rights letters. Some insurers aggressively and unnecessarily reserve their rights as a matter of procedure, while others prudently reserve their rights when circumstances dictate. We must not forget, nor let the consumer forget, that our industry sells a service to protect the assets of policyholders and price isn't everything.